Some of the factors relied upon by the AAR to arrive on such a conclusion were:

• The applicant was formed only during the final stages of the bid process and was not included in the initial stages;
• AAR could not be satisfied with the commercial substance or economic rationale for interposing of the applicant incorporated in Mauritius. AAR concluded that based on the nature of the project, there was no commercial reason for setting up the special purpose vehicle in Mauritius, given that it earned no reputation as a financial hub or a seat of civil aviation experts; and
• The applicant company was a shell/conduit entity having no assets, employees, office space;

Further, despite the absence of a ‘limitations of benefits’ clause under the India-Mauritius tax treaty, it was held that ‘beneficial ownership’ and commercial substance are key factors for determining the availability of tax treaty benefits.

More recently, the controversy around denial of tax treaty benefits has again come to life with another ruling of the AAR concerning the seminal deal in both the e-commerce and India’s indirect transfer tax space, and attracted Indian tax office’s attention even as the transaction was ongoing.

The Delhi Bench of the AAR – In re: Tiger Global International Holdings, Mauritius^[3]

In 2019, Walmart acquired the shares of Flipkart Private Limited, Singapore (“Flipkart“), a company, which substantially derived its value from Indian assets, from its shareholders (that comprised of several private equity funds). Walmart had withheld taxes in accordance with withholding tax certificates that the sellers had procured from the Indian tax office. Accordingly, the sellers were to make their tax treaty claims directly before the tax office for seeking a tax refund.

Tiger group, one of the private equity sellers, claimed the benefit of the grandfathered capital gains tax exemption under the India-Mauritius tax treaty. When the tax office rejected its claim whilst issuing the withholding tax order, Tiger filed an application for an advance ruling before the AAR. The AAR rejected Tiger’s advance ruling application holding that the transactions in question were prima facie designed for tax avoidance. It ruled that Tiger’s control and management was in the US and that the Mauritian entities were see through, having no independence or purpose other than availing tax treaty benefits.

AAR’s key findings

Lack of non-tax purpose in the organization structure

AAR noted that Tiger’s selling entities are part of a group managed by Tiger Global Management LLC USA (“Tiger USA“). Tiger USA held Tiger selling entities through a web of intermediaries based in Cayman Islands and Mauritius. It observed that the only intent and purpose for which such subsidiaries were set up was to avail the benefits of the India-Mauritius tax treaty. AAR noted that Tiger selling entities had not made any other investments, other than making investments in India.

Control and management of Tiger’s selling entities

AAR defined ‘control and management’ to mean the ‘head and brain’ of the company as against management of day-to-day affairs. AAR examined the minutes of board meetings and other documents pertaining to Tiger entities to note that certain individuals, who were not residents of Mauritius and held key positions in Tiger USA, were taking key strategic decisions for Tiger selling entities. Moreover, such individuals also exercised authority to operate bank accounts (beyond a certain monetary threshold) of such entities. Accordingly, AAR ruled such individuals should be treated as the ‘head and brain’ of Tiger selling entities, which is in USA and not Mauritius.

Eligibility to tax treaty benefits

AAR also summarily held that the capital gains tax exemption under the India-Mauritius tax treaty (which, grandfathered investments made prior to March 31, 2017 post the amendment in the tax treaty) did not apply to indirect transfers. Accordingly, Tiger’s selling entities were in any case not entitled to treaty benefits on the sale of Flipkart, which resulted in indirect transfers of Indian entities.

Conclusion

Both the above ruling have come as a reminder that benefits under the India-Mauritius tax treaty may be denied even for the grandfathered investments merely by virtue of holding a valid TRC. Parameters for establishing commercial substance and beneficial ownership should be borne in mind by Investors while structuring their investments. Further, details such as source of funding, date of incorporation, presence of the taxpayer in terms of employees, office space etc., as well as the commonality in management between the seller and its parent shall continue to be reviewed closely.

The India-Mauritius tax treaty route has been called into question yet again, as the AAR latently questions the tax residence of the Tiger entities in Mauritius, their principal purpose and the commercial substance underlying the holding company structure. Curiously, the AAR ruling also concludes of tax treaty benefits not applying to indirect transfer (contrary to High Court’s decision in the Sanofi case).

These rulings will affect withholding tax related negotiations in the on-going and future deals. Buyers, who were so far accepting treaty benefit claims basis market level tax opinions and indemnities, may push sellers to obtain withholding tax orders pre-closing.

As this old debate resurfaces every few years and with statutory anti-avoidance rules in play, private equity players need to relook their management and organizational structures to pass the muster of commercial substance related smell tests.

Footnotes

[1] 263 ITR 706 (SC)

[2] Bid Services Division (Mauritius) Ltd, In re ([2020] 114 taxmann.com 434 (AAR – Mumbai))

[3] AAR No.04/2019, 05/2019 and 07/2019, Decided on March 26, 2020.

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